Rebound in GDP growth

Bottom line

A surge in corporate investment and better-than-expected personal consumption in the first quarter sparked a solid 2.0% increase in economic growth. We are also about halfway through a very strong first-quarter corporate reporting season. In conjunction with powerful results to date — in which revenues and profits soared 12% and 25% year-over-year (y/y), respectively — the S&P 500 broke 7,200 for the first time yesterday. That caps an eye-popping 14% risk-on rally since the equity market’s trough on March 30, with April its strongest month in six years (up 10.4%).

GDP growth rose 2.0% in the first quarter of 2026, which was slightly below the Bloomberg consensus of 2.3%, but well above the aberrant increase of only 0.5% in last year’s fourth quarter. That compares with much stronger growth rates of 4.4% and 3.8% in the third and second quarters of last year, respectively. Federated Hermes was expecting 2.5% growth in the first quarter of 2026; the Blue-Chip consensus estimate was at 2.4%; and the Atlanta Fed’s “GDPNow” tracking estimate was at 1.2%. 

Private domestic final sales rose This metric gauges the underlying fundamental strength of the economy, focusing on the three core elements of GDP growth, which include personal consumption, corporate spending, and residential construction. By design, it excludes volatile inventory liquidation or restocking, net trade, and government spending. In the first quarter, this metric grew by 2.5% quarter-over-quarter (q/q) versus 1.8% in last year’s fourth quarter and 2.9% increases in the third and second quarters.

What happened in the first quarter? Personal consumption rose by a slightly better-than-expected 1.6% q/q in the first quarter (consensus at 1.4%), which added 1.08 percentage points to overall growth. Corporate spending soared by a nearly three-year high of 10.4% q/q — paced by double-digit gains in equipment and intellectual property — which added 1.39 points. But residential construction continues to struggle, plunging for the seventh time over the past eight quarters (-8.0% q/q). That trimmed 31 basis points. Adding these three components together, private domestic final sales grew a solid 2.5% in the first quarter.

Overall government consumption rose 4.4% q/q in the first quarter, which added 0.73 percentage points to GDP growth. Within that broad category, federal government spending rose 9.3% q/q. That is a sharp reversal from the fourth quarter’s 16.6% decline and added 0.56 points. 

Inventories declined sequentially by $7.5 billion in the first quarter — smaller than the fourth quarter’s $15.6 billion decline — adding 40 basis points to overall GDP growth. Finally, net trade worsened in the first quarter, as a strong 12.9% increase in exports was swamped by a huge 21.4% increase in imports, resulting in a 1.3 point decline. 

Aberrant fourth quarter The longest federal government shutdown in history last October and November forced a decline of 16.6% in government spending, which subtracted 1.16 percentage points from fourth quarter 2025 GDP growth. With private domestic final sales up 1.8% in the fourth quarter, overall GDP growth likely would have approximately a trend-line 3.0% rate instead of its 0.5% print if the federal government had been open.

Inflation moves higher Due to the Iran conflict over the past two months, crude oil prices (West Texas Intermediate, or WTI) have surged 70% from $65 at the end of February to approximately $110. Over this same period, lagging gas prices at the pumps have risen 44% from $2.98 per gallon to a four-year high of around $4.30. While nominal inflation certainly rose in March and likely April, the increase in oil costs has begun to filter into core inflation, too, which strips out volatile food and energy prices. The nominal Personal Consumption Expenditure (PCE) index spiked to 3.5% in March y/y, up sharply from 2.8% in February. Core PCE (the Federal Reserve’s preferred measure of inflation) rose by 3.2% y/y in March versus 3.0% in February. That’s up from a four-year low of 2.6% in April 2025.

Fed on hold The Federal Reserve left the federal funds rate unchanged at a three-year low of 3.50-3.75% at its policy-setting meeting on Wednesday. The leadership transition to Kevin Warsh from Jerome Powell as Chair on May 15 is in full swing. The labor market has firmed and initial weekly jobless claims of 189,000 for the week ended April 25 are the lowest since 1969. Energy prices and inflation are clearly a near-term problem, and two-year Treasuries are now yielding 3.88%. It is unlikely that the Fed will take action on interest rates, up or down, until after Warsh delivers his first keynote speech at Jackson Hole, Wyo., in late August. 

Details in the first-quarter GDP report:

• Personal consumption (which accounts for nearly 70% of GDP on a chained-dollar basis) rose 1.6% q/q in the first quarter (contributing 1.08 percentage points to the gain in overall GDP), slightly better than the expected consensus increase of 1.4%, but below the fourth quarter of 2025’s 1.9% gain. While nominal retail sales surged by a one-year high of 1.7% month-over-month (m/m) in March, “control” results (which exclude volatile energy, food, building materials and autos) rose a solid nine-month high of 0.7% m/m. This metric feeds into GDP, which suggests a potential upward revision.
• Corporate non-residential capital spending surged by a nearly three-year high of 10.4% q/q in the first quarter (which added 1.39 percentage points to overall GDP growth), up from a gain of 2.4% in last year’s fourth quarter. This surge in corporate capex spending was the highlight of the quarter, as the immediate-expensing provision of capital goods in the One Big Beautiful Bill has boosted US productivity over the past three quarters by 3.7%, compared with a 50-year average of 1.9%. True, structures declined by 6.7% for the fifth consecutive quarter. But equipment spending leapt 17.2% in the first quarter and intellectual property spending grew 13.0%. 
• Residential construction declined for the fifth consecutive quarter and for the seventh time in the last eight quarters, falling by 8.0% q/q in the first quarter (the worst period since the fourth quarter of 2022), which subtracted 0.31 percentage points from overall GDP growth. With the Fed on hold, mortgage rates are too high, existing homeowners are reluctant to surrender their low existing mortgage rates, and inventory levels are low. House prices leapt 50% since the pandemic; affordability has not been this bad since the mid-1980s.
• Inventories declined $7.5 billion in the first quarter, which added 0.40 percentage points to GDP growth, because that level of liquidation was less than the $15.6 billion inventory decline in last year’s fourth quarter.
• Government spending rose 4.4% q/q in the first quarter (which added 0.73 percentage points to overall GDP growth), in stark contrast to the 5.6% fourth quarter 2025 decline, subtracting 0.99 points. This was the direct result of the government shutdown. To demonstrate, federal spending rose 9.3% in this year’s first quarter (adding 0.56 points) but it plunged by 16.6% q/q in last year’s fourth quarter (subtracting 1.16 points).
• Net trade was the biggest drag in the first quarter, subtracting 1.3 points. The pace of export growth surged by a more than three-year high of 12.9% q/q, which added 1.32 points. But import growth of a one-year high of 21.4% q/q more than offset that surge in exports, subtracting 2.62 points. The major technology hyperscalers have committed to spending an estimated $725 billion in AI data centers this year alone, and much of that equipment is imported.

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